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Against the background of Jackson LJ’s review of civil litigation costs, increased marketing activity on the part of third-party litigation funders, and debates surrounding access to justice versus the significant cost of defending litigation in England and Wales, it’s hardly surprising that many lawyers are struggling to know which way is up in the complex and ever-changing litigation risk-transfer market.

Rule 2.03 of the Solicitors’ Code of Conduct 2007 imposes an obligation to give clients information about the cost of litigation, and this duty expressly includes an obligation to discuss after the event (ATE) insurance. In practical terms, no advice about the cost of commercial litigation can be complete without considering CFAs, ATE insurance and third-party funding.

It’s fair to say that the commercial litigation community has been slow to embrace litigation risk sharing – some commercial litigators still will not consider conditional fee agreements (CFAs), often because they regard them as ‘all or nothing’. In reality, in the commercial context, it is generally discounted CFAs or ‘no win, low fees’ that prevail, often with only a nominal proportion of the fee actually at risk on the outcome.

Some litigators still have little or no practical experience of working with litigation risk-transfer products offered by third parties, including specifically ATE insurance and third-party funding, and so lack the market knowledge which is essential in order to provide relevant advice. Others may have considered litigation insurance or funding in the past, but when exploring the possibility further, found themselves plagued by limited availability in an underdeveloped market, which was so off-putting that they have never seriously revisited the issue again.

WHAT HAS CHANGED?

Happily, today’s commercial litigation risk-transfer market is a very different animal to the market that existed a few years ago: there are now many reputable providers routinely offering a variety of useful products that are being applied across the full spectrum of commercial litigation. Deferred ATE insurance premiums, which are only payable in the event of success, are now the norm. In addition to this an ATE insurance premium is, of course, a recoverable cost in the litigation, under s.29 of the Access to Justice Act 1999.

These policies will cover the potential liability for the opponent’s costs in the event of a loss of split-costs outcome. However, they will generally also cover the policyholder’s own disbursements, and it may even be possible to extend the cover to include some of the policyholder’s own solicitors’ fees.

ATE has an extremely wide application: almost every area of commercial litigation is now potentially insurable, including many areas which were historically regarded as problematic by insurers, such as construction or IP. The capacity available in the market has also changed: recent high-profile cases such as Brown & ors v Innovatorone Plc [2009] show that A-rated insurance markets are willing to write multimillion-pound limits on individual risks, something that was virtually unheard of even a few years ago. These developments, when combined with the availability of deferred and self-insured premiums, mean that litigation insurance is no longer simply regarded as a distress purchase, but is now highly relevant to well-capitalised clients as a means of hedging the financial risk of litigation and bringing a degree of certainty to the balance sheet in terms of the legal spend.

For clients who cannot afford the interim costs of litigation, are at risk of being outspent by a wealthy opponent, or simply do not have the stomach for a fight, third-party litigation funding can be secured, which offers effectively cost-free, risk-free litigation, provided that the client is willing to share the proceeds of its claim upon success.

However, this doesn’t mean that it is always plain sailing for lawyers. Indeed, many would say that a sophisticated market has brought with it more pitfalls to avoid when advising clients. It is no longer a case of charging an hourly rate to litigate a case: now lawyers are expected to consider sharing the risk themselves, negotiate with insurers and third-party funders (or use a broker), find suitable terms for the client at a competitive price, and help the client to comply with their ongoing reporting obligations.

So what do lawyers need to know in order to discharge their obligations to the client? Better still, what can lawyers do to use the available products to their tactical advantage in litigation, and to generate business by using a proactive approach to client risk management?

GO SHOPPING

One of the easiest mistakes to make is to put all of the client’s eggs in one basket. While it is certainly tempting to build a relationship with one or two providers and refer all potential cases to them, this approach can be dangerous.

As an example, failing to shop around means that the client has no points of comparison in terms of price. One might say that because an ATE premium can be deferred, self-insured and recovered from the opponent on success, why should the client care how much it costs? The difficulty is that the premium can only be recovered if it is reasonable, and it may be difficult to justify the reasonableness of the premium without a point of comparison.

However, ATE premium recoverability is only half of the story. In reality, commercial litigation often concludes by way of global settlement, in which case there will be no recover of costs per se and the client will be liable to pay the ATE premium out of the net recovery. In those circumstances, the client needs to be confident that they are not paying over the odds for their insurance.

These issues are magnified when considering third-party funding. In the current market, a funder is probably unlikely to get out of bed for much less than a two- or three-fold return on their investment, and many deals see the funding costing significantly more than that. For the client, this is a significant and irrecoverable cost and the net financial outcome of the case will be a direct result of the funding deal structure. For example, the apparently subtle difference between, say, a fee of 2.5x outlay and a fee of 3x outlay, or a fee of 25% of the recovery and a fee of 30%, could mean a difference of several millions for the client, so it’s vital to shop around to make sure that the terms are competitive.

It’s also important to bear in mind that, no matter what some marketing literature might suggest, in the absence of some sort of binding agreement, no insurer of funder can guarantee assistance with every case. The underwriting process is inherently subjective and the decision-making can be influenced by an incredibly wide range of factors. If the case is rejected by a first provider, this fact will have to be disclosed to subsequent providers approached, which will inevitably be off-putting and may significantly reduce the client’s chances of getting an offer at all.

ATE PREMIUM RECOVERABILITY

Although many settled cases will not see a recovery of costs, if the case goes to trial and wins, or is settled on a ‘plus costs’ basis, it’s important for the solicitor to arm themselves to defend any attack on the reasonableness of the premium by the paying party.

So what should we bear in mind when advising a client about ATE insurance, in order to minimise the likelihood of seeing the client’s premium reduced or disallowed by the court on assessment? According to CPR Rule 44.5 and s11 of the Costs Practice Direction, the court will look at a number of factors as being relevant to the cost of an insurance premium, including for example ‘the level and extent of the cover provided’, ‘the availability of any pre-existing insurance cover’, and whether the premium would be rebated in the event of early settlement.

The test for reasonableness was helpfully summarised by the Court of Appeal in Callery v Gray (no 2) [2001], where it was held that the court will:

…be concerned with the question of whether the premium is a reasonable price to pay for the benefits that it purchases. Ultimately, this should be a question to be considered having regard to experience, or evidence, of the market.

Other important points include whether the premium is proportionate, which, according to Rogers v Merthyr Tydfil CBC [2006], means proportionate to the insurer and not necessarily proportionate to the value of the claim. The amount of cover purchased will also be relevant: if the client has bought far too much cover, the paying party may argue that the premium is unreasonably high as a result.

There are a number of other points, but the key issue is invariably that alluded to in Callery. To demonstrate reasonableness, the policyholder will need evidence of the market, and what better evidence than a number of quotations (or indeed the lack thereof) obtained following a search of the market?

BE CREATIVE

In litigation funding, there is rarely such a thing as ‘one size fits all’ and the easiest option may not necessarily be the most suitable or the most cost-effective. The challenge is to think about the specific features of the case and consider how the various options might respond in the range of possible outcomes to the litigation, and what the potential cost to the client would be in each of these possible outcomes.

For example, take a commercial client in some financial difficulty and facing an application for security for costs. An obvious solution would be to approach a third-party funder, who could provide funds to pay into court in exchange for a share of the case proceeds on success. However, another solution would be to consider litigation insurance. Cases such as Al-Koronky and anor v Time Life Entertainment Group Ltd & anor [2006] suggest that while the existence of a policy may persuade the court not to make an order for security for costs, if an order is made, the policy in isolation may not be deemed adequate, as the cover will necessarily have limitations and exclusions.

The importance of the extent of the claimant’s ATE cover to the defendant was highlighted in the recent Barr & ors v Biffa Waste Services Ltd [2009]. In that case, when ordering the disclosure of the ATE policy, the court endorsed the approach of Gray J in Marion Henry v British Broadcasting Corporation [2005], that the:

…amount of cover and the existence of material exclusions in the policy are of obvious relevance to the opposite party, who must be in a position to make informed choices as to the conduct of the litigation.

Interestingly, although there is a risk that an ATE policy will not satisfy security for costs, many of the leading insurers can now support an ATE policy with a bond, effectively providing a guarantee to pay a certain amount of any claim should the case be lost. While there is an additional cost for an ATE insurance bond, this is still likely to be a fraction of the cost of equivalent third-party funding.

THE RETAINER IN THE MIX

Far from being ‘all or nothing’, we are increasingly seeing innovative approaches to CFAs being combined with other litigation risk-transfer options. One possible (and increasingly popular) structure sees a three-way split of the solicitor’s fee. The solicitor risks one-third on a CFA, with the client paying the remaining two-thirds on the usual basis. The client then insurers half of its fee outlay in the event of a loss (i.e. one-third of the overall fee), together with the usual disbursements and adverse costs. This structure both assists the solicitor with the case-flow and certainty, and provides the client with a significant hedge on its risk, while offering a useful risk alignment between the three stakeholders.

Does this mean that the solicitor always needs to be acting on a discounted CFA in order to secure insurance or funding for the client? Far from it: most leading insurers and funders will now comfortably assist with cases where there is no CFA in place. That being said, where there is a willingness to offer a discounted CFA (with even only a modest proportion at risk), it will always be easier to persuade an independent third-party insurer or funder to come on board, while demonstrating to the client that the legal team will share its fortunes.

In many cases, it’s simply a subtle mentality-shift on the part of the law firm. We regularly see magic circle firms slashing charge-out rates to win business, when in fact simply looking more carefully at risk-sharing might present a more attractive proposition for the prospective client and law firm alike.

THE FUTURE OF RISK-SHARING

A point which is perhaps obvious by its omission is Jackson LJ’s ongoing review of civil litigation costs. It remains to be seen what, if any, substantive changes to CFAs, ATE, litigation funding and costs shifting will result, but it is clear that whatever these changes might be, it will be some time before they become a reality for litigants.

It the meantime, the availability, sophistication and awareness of commercial litigation risk-transfer options are continuing to increase rapidly. The question is therefore whether to treat the options as a necessarily evil, providing clients with only the minimum advice in order to comply with Rule 2.03; or, like many, to embrace the options that exist and use these to your and your client’s advantage.

When disclosed to the opponent, the existence of funding or insurance will very often have a powerful tactical impact, demonstrating that the client has the means and stomach for a fight and that an independent party has reviewed the case and taken the view that the client is likely to win.

What is more, many firms are now actively promoting their approach to risk management and using this as an aid to business acquisition and client retention. In these uncertain economic times, a lawyer who can demonstrate a willingness to share and hedge the client’s financial risk is surely going to be a good place to start when embarking on litigation.

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